Taxi markets are a perfect test of Europe’s willingness to change. The first in an occasional series on structural reform

MANY a journey starts in a taxi. So it is with the road to deregulation in the euro zone's economies. Mario Monti, Italy's prime minister, has prioritised liberalisation of taxi licences; Italy's cabbies are striking as a result. Greek taxi-drivers have blockaded streets several times in protest against deregulation. Why have taxis become emblematic of the battle to free hidebound economies?

The superficial answer is that taxis are iconic: think of the badges, the bold colours and the recognisable models. The complex answer is that these features are themselves the result of regulation, and not just in the euro zone. From the turning-circle of a London taxi to the medallions on the hood of a New York cab, this industry picks up rules as easily as fares.

Taxi markets should be simple. Costs of entry are low. There are rarely large incumbent firms. On paper, competition should flourish. But low barriers to entry create a risk of having too many taxis on the roads. The number of taxi drivers in New York and Washington, DC, shot up between 1930 and 1932, as the unemployed sought work during the Depression. Such surges lead to rules to reduce congestion. America started to set up new regulatory authorities in the early 1930s; Britain established binding numerical limits on horse-drawn coaches way back in 1635.

Cab fares can be problematic, too. Unregulated competition means that fares fall to little more than a driver's expenses. These expenses are influenced by distance (fuel costs), duration (the cost of time) and destination. The end-point for a trip is vital: some destinations (airports, say) will pretty much guarantee a return fare; others will not. This means journeys of a similar distance can have very different costs, so working out a fair price is tricky. In an unregulated market passengers would have to search out a competitive price, a time-consuming process of hailing or calling a number of cabs. That allows taxi operators to run an opaque pricing structure.

The response to this problem in many jurisdictions has been regulation to establish a uniform price, giving customers certainty over what they will pay. But as a result journeys that are the same distance end up varying hugely in value for drivers. Short trips around tourist destinations are lucrative; trips to more remote areas, or on congested commuter routes, are much less profitable. Since full-time cabbies cannot raise prices, they may refuse to operate at less popular times or to carry passengers who live at the wrong end of town.

The answer has been to layer on yet more regulation aimed at enforcing uniform pricing, geographic coverage and quality standards. Rome and Mumbai operate hard geographic barriers to entry: those who live outside the cities cannot operate inside them. A better idea is imposing an entry cost for a permit that a driver loses if found to be violating the rules. This creates a commitment to the industry and an incentive to play fair. The New York medallion system works this way: a driver caught violating rules is banned and the medallion suspended, so both the driver and medallion-owner lose out.

But even well-thought-out regulations end up not working. Drivers of London's black cabs must learn the city's streets by heart but these tests can now take four years to complete (in 1960 it took up to a year), which acts as a bottleneck to new supply. That a New York medallion sells for over $1m suggests well-intended commitment devices can simply become a barrier to entry.

Hackneyed protest

Incumbent drivers argue that more taxis might help travellers but would dent profits, putting low-value trips at threat and reducing cab quality. But the idea that markets are a zero-sum game is a bad one. Loosening quantity restrictions might benefit both drivers and passengers. More cabs mean lower waiting times and can increase the number of travellers who choose to use taxis. The market grows. This could boost utilisation rates and profits.

There is supporting evidence. In 1998 Dublin suffered from a distorted licensing system. Demand had doubled in the previous 20 years but the number of licences had not kept up. Waiting times were over an hour. Deregulation in 2000 reduced entry costs (the cost of a car and a licence) by 74%. The result was more than three times as many cabs on the roads, lower waiting times, maintained cab quality and higher passenger satisfaction—all in two years.

In Tehran taxi supply is flexible, rising and falling with demand. A shared-taxi system operates, allowing any private car to pick up passengers. Because travellers can hop on and hop off as they please, a driver can carry passengers travelling to different destinations at the same time. This boosts utilisation, just as a bus route does. The system also means the quantity of taxis is truly fluid, rising during rush hour as commuters pick up a few passengers on their way home. It would be hard to design regulation that worked this well.

The Swedish experience suggests one downside to deregulation. Following the country's banking crisis in 1990 lots of industries were deregulated. For taxis price controls, restricted operating times and regulated zones were all swept away. The year after deregulation the number of taxis per inhabitant had risen by 28%. But fares to rural areas (low-value one-way trips) rose, in line with theory. One solution would be to subsidise taxi fares to some rural areas where buses do not operate.

The regulatory straitjacket that characterises the taxi industry may have been fitted for valid reasons. But barriers to entry make markets smaller. Dismantling layers of regulation to increase market size and efficiency is the rationale behind structural-reform efforts in the euro zone. If these economies are to change, the taxi is as good a way as any to start the trip.